# Construct sparse portfolio with mutual fund's favourite stocks in China A share market

**Authors:** Ke Zhang  
**arXiv:** [2305.01642](https://arxiv.org/abs/2305.01642)  
**Date:** 2023-04-24  
**Summary page:** https://www.summarizepaper.com/en/paper/2305.01642v1/

## Key points

- China A share market has been dominated by retail and unprofessional trading in the last 20 years
- Professional investors have consistently generated excess returns compared to the total market index through their stock selectivity ability
- Quantitative approach was used to construct a sparse portfolio that takes advantage of favorite stocks by mutual funds in China A market
- Mutual funds outperformed the total market index due to inefficiencies in emerging markets
- Two portfolios were built: one with high correlation (0.985) and another low-risk balanced portfolio that consistently outperformed the partial equity funds index regarding return and Sharpe ratio
- Each industry exposure of the portfolio was restricted within 10% to reduce sector risk and build a more balanced portfolio
- The resulting industry exposure graph showed that while Industry, Finance, Health care were all around 10%, they were lower than their weight in 930950.CSI. Energy and Utility were overweight compared with 930950.CSI.
- Our portfolio had better total return, lower volatility, and higher Sharpe ratio compared with either partial equity funds index or total market index.
- Our portfolio had lower maximum drawdown than both benchmark indices.
- Constructing a sparse portfolio with mutual fund's favorite stocks in China A share market using quantitative methods can lead to excess returns.

## Summary

The China A share market has been dominated by retail and unprofessional trading in the last 20 years, unlike developed markets. However, professional investors in this market have consistently generated excess returns compared to the total market index through their stock selectivity ability. To achieve excess returns from the mutual fund industry, a quantitative approach was used to construct a sparse portfolio that takes advantage of favorite stocks by mutual funds in China A market. The first step was an analysis of mutual funds and their holdings in China A share market. The research showed that mutual funds outperformed the total market index due to inefficiencies in emerging markets. Next, different methods were compared for constructing a sparse portfolio with individual stock and industry exposure constraints to track partial equity fund index. Finally, two portfolios were built: one with high correlation (0.985) and another low-risk balanced portfolio that consistently outperformed the partial equity funds index regarding return and Sharpe ratio. To reduce sector risk and build a more balanced portfolio, each industry exposure of our portfolio was restricted within 10%. The resulting industry exposure graph showed that while Industry, Finance, Health care were all around 10%, they were lower than their weight in 930950.CSI. Energy and Utility were overweight compared with 930950.CSI. The performance of our portfolio was compared with benchmark indices using total return (%), volatility (Vol), and Sharpe ratio calculated by log return. Our portfolio had better total return, lower volatility and higher Sharpe ratio compared with either partial equity funds index or total market index. Furthermore, we analyzed maximum drawdowns of three strategies which revealed that our portfolio had lower maximum drawdown than both benchmark indices. We also considered using portfolio return minus benchmark indices which showed two equity curves gradually going up, indicating that our portfolio could beat these two indices in the long term. In conclusion, this study demonstrated that constructing a sparse portfolio with mutual fund's favorite stocks in China A share market using quantitative methods can lead to excess returns.